5 mistakes in investing for retirement and how to fix them

A common misconception is that the expenses will reduce in retirement years.

He started early, saved regularly and never dipped into his retirement kitty. Yet, when Punit Chahar took stock of his retirement savings, the corpus was far smaller than what he had expected. “I focused entirely on risk-free investment options such as the Public Provident Fund and bank deposits,” says the Agra-based self-employed professional (see picture).

Punit Chahar, 42, AgraHis mistake: Started saving for retirement very early, but played too safe. After almost 13 years of investing in PPF and fixed deposits, he realised he will not reach his target.
How he fixed it: Two years ago, he started shifting his savings from fixed deposits to equity funds. He currently has 60% allocated to equities.

In Delhi, businessman Vivek Bakshi is ruing the day he took a friend’s advice and gave his retirement portfolio a dash of equities. Though experts recommend this, Bakshi made fundamental mistakes when he went shopping on Dalal Street. A newbie, he invested in stocks directly, and that too when retirement was just a few years away. Though the overall market was booming in 2014, he lost around Rs 4 lakh in one month.

Chahar and Bakshi represent the two extremes of the risk spectrum. One took too little risk with his retirement savings and lost the opportunity to build a large corpus. The other took too much risk and saw his wealth erode.

Experts warn that equity investments should not be done with a shortterm horizon. “It is harakiri to invest in stocks directly to make up for the shortfall in retirement corpus,” says Ashish Shanker, Head-Investment Advisory, Motilal Oswal Private Wealth Management. At the same time, relying too much on fixed income options for the long term can also be risky. “In the long-term, investments in fixed income products are just as risky as equity investments are in the short-term,” says Atul Singh, CEO, WGC Wealth.

This week’s cover story looks at common investing mistakes that can ruin the retirement plans of an individual. Some of these mistakes, like Chahar’s over-dependence on fixed income products, can be fixed. He realised his mistake in time and was able to affect a course correction. Two years ago he started moving his retirement savings from fixed deposits to equity funds. The 42-year-old now has about 60% of his retirement corpus in equity funds.

However, some mistakes, like Bakshi’s ill-advised foray into equities a few years before retirement, cannot be undone. “It was a terrible mistake. I will just have to live with the consequences,” says the 60-year-old (see picture).

Vivek Bakshi, 60, DelhiHis mistake: Invested Rs 7 lakh in stocks for high returns a few years before retirement and lost Rs 4 lakh within a month.
Can he fix it: Small investors with no knowledge of stocks should avoid direct investments. The mutual fund route is a safer and better option. He will not be able to recover his loss.

Don’t commit harakiriStocks are inherently volatile but some experts contend that they are necessary if you are investing for long-term goals. “Longterm investments must be kept in equitybacked investments if you do not want to expose yourself to old-age poverty,” says Dhirendra Kumar, CEO of Value Research. Investors like Bakshi can also insulate themselves against big losses by taking the mutual fund route. Given the diversification followed by mutual funds, the chances of losses reduce further. Studies show that the probability of loss in equity-based investments decreases as the investment tenure increases. Chances of loss is highest if you hold an equity fund for one year, but come down dramatically if the holding period is longer than five years. If held for 10 or more years, the probability of loss is almost nil.

Not many investors take heed of these numbers. Most of them rely heavily on fixed income and insurance policies when saving for retirement. A survey by Exide Life Insurance found that about 58% of the 2,408 respondents opted for bank deposits and the Provident Fund for retirement planning and almost 49% had bought life insurance policies as part of their plan.

Some experts suggest investments through SIPs in equity oriented funds, but only if the investor has the risk appetite. However, expectations should be set straight. “The investor would be disappointed if he expects unrealistic CAGR returns over a 3-4 year investment period,” says Tarun Birani, CEO, TBNG Capital Advisors.

The risk in insuranceMany investors consider endowment policies an ideal way to save for retirement because of the multiple benefits they offer. These policies enforce a saving discipline, offer tax deduction on the premium, cover the life of the individual and the maturity proceeds are tax free. But look under the hood, and it is clear why these policies are not very helpful. The returns are less than 6% even if you go for a long-term plan.

The life cover is usually 10 times the annual premium, which is often insufficient to provide financial protection to a family. To buy a cover of Rs 10 lakh, a person will have to shell out a premium of Rs 1 lakh every year. “It is likely that the premium you are willing to pay in a year will leave you with an insufficient cover,” says Suresh Sadagopan, Founder of Ladder7 Advisory.

Pune-based Dilip Shirke knows this only too well. Shirke has three endowment policies that cover him for Rs 7 lakh and will give him a return of around 5.3%. He pays an annual premium of roughly Rs 20,000 and is planning to surrender the high-cost policies. Though the surrender value will be less than the premiums he has paid till now, Shirke will be able to channelise the money into more lucrative investments and buy a term insurance plan for himself.
Dilip Shirke, 34, Pune His mistake: Holds three endowment insurance policies that cover him for Rs 7 lakh but gobble up over Rs 20,000 in premiums every year. Also, the family depends solely on group health cover.
Can he fix it: Surrendering an endowment policy leads to losses, but continuation only increases the loss. Close the high-cost plans or turn them into paid-up plans. He intends to buy a family health cover after 40 but is advised to do so now.

Going wrong with estimatesSaving regularly and in the right instruments will not safeguard your retirement if you do not estimate correctly how much you will need in your sunset years. Experts point out that many investors fail to factor in inflation while calculating their retirement kitty. Inflation has the power of compounding. If you currently require Rs 50,000 a month for running the household, 6% inflation would increase the monthly requirement to Rs 70,000 in six years. In 10 years, it would be Rs 90,000. In 25 years, you will need more than Rs 2 lakh a month to sustain the same standard of living. If you have not taken inflation into account, be ready to live a life that will be substantially poorer than how you live now.

Keep in mind the impact of lifestyle inflation on your retirement needs. Over time, as the income of the individual goes up, the standard of living improves. For instance, a junior manager will purchase a basic TV or fridge at 30. But a senior manager, who earns more and has a bigger family, will prefer to buy a premium model. As income rises, the family starts spending more on premium products and services. So the corpus requirement estimated at 30 might have to be reviewed at regular intervals.

Another misconception is that the expenses will reduce in retirement years. “People think they can get by on a smaller budget in retirement. While the person may not have to spend on children’s education and all loans may be paid for, the travel and healthcare expenses usually increase after retirement,” says Bhakti Rasal, a Mumbai-based financial planner.

There is a growing interest in traveling and pursuing new hobbies among retirees. In a study of 900 working professionals and 100 retirees conducted by Aegon Centre for Longevity and Retirement last year, about 54% respondents said that traveling is a retirement aspiration. Apart from traveling, costs related to gifting to grandchildren, household help, socialising and healthcare are likely to increase post retirement. Also, due to increasing shift to nuclear family structure, expectations of financial support from your children should be kept minimal. A study by HSBC revealed that 68% of working age people expect financial support from their children in retirement whereas only 30% of current retirees actually get it.

Putting retirement corpus in 1-2 income productsEven if you have saved enough, you can still sabotage your retirement by putting all your eggs in one basket. Experts say your retirement tool kit should be a mix of various products.

For instance, it is not a good idea to put a large sum into an annuity plan. Though annuities assure life-long pension and are an insurance against the threat of outliving your money, they also offer low returns that won’t be able to beat inflation in the long run. Annual returns of the Jeevan Akshay online annuity with return of purchase price is 6.5%, which may not be very useful if inflation spikes. Keep in mind that inflation in healthcare, which is a major expense in retirement, is higher at 10-12% compared to the overall wholesale basket.

Annuity has poor liquidity too. Once you annuitise your savings, it gets locked forever. Even in the case of annuity with return of capital, the balance amount is paid to the nominee only after the death of the annuitant. Experts suggest a diversified income portfolio to optimally meet your retirement needs. “Annuity should never be more than two-third of the retirement corpus,” says Santosh Agarwal, Associate Director and Cluster Head of Life Insurance, Policybazaar.com.

Government schemes of SCSS and Pradhan Mantri Vaya Vandana Yojana (PMVVY) offer relatively high assured annual returns of 8.7% and 8%. Tax-free bonds or systematic withdrawal plan (SWP) in mutual funds offer even better post tax returns. “SWPs from mutual funds held over time will attract minimal tax due to indexation benefit,” says Shanker of Motilal Oswal. In the case of SWP, flexibility in withdrawals and capital appreciation helps in providing for increased needs in the future. “You can increase withdrawal amount to keep up with inflation,” says Amit Suri, CEO and Chief Financial Planner, Aum Wealth Management.
Don’t rely on group health cover aloneHealth benefits offered by an employer can provide some cushion, but not buying individual health policy in early years can prove to be a costly mistake in retirement. The employer’s insurance coverage will cease on retirement, which is when you will need insurance coverage the most. But health insurance becomes more expensive when you are old. If you have developed some medical condition, the premium shoots up.

Experts say that even after buying a separate cover most people find it difficult to meet healthcare expenses in retirement. This could be due to buying insufficient coverage to keep premiums low or buying the wrong policy only for the purpose of saving taxes or not gauging increasing healthcare costs while planning for retirement. “One should include medical expenses while calculating the retirement corpus. Keep some money aside for those components that do not get paid by insurance companies,” says Rasal.

Buy an individual health plan early in your career to avoid high premiums and numerous medical tests insurance companies mandate after 50. Also, the no-claim benefits accumulated over the years will increase the extent of your cover. It would be wise to evaluate and increase your coverage every five years to align it with increasing healthcare costs.